Reverse currency wars’ is real 

Many countries complained that the resulting dollar weakness would hurt their trade in a low-growth world and force them to overheat by trying to match the Fed’s easy money in the 10 years after the US Federal Reserve originally set out on bond-paying quantitative facilitating to avert collapse.

But that all changed after the Fed’s aggressive move this year to rein in 40-year-high inflation with sharply higher interest rates, a halt to new asset purchases, and a planned rundown of its $8 trillion-plus balance sheet.

As a result, the dollar’s index against other major currencies has risen nearly 20% in the last year, leaving US trading partners with the opposite problem of trying to support rather than cap currencies for fear that their weakness would make dollar-priced energy and food imports even more expensive, exacerbating already-high inflation everywhere. 

For a really long time, monetary firms like Goldman Sachs have cautioned that long-battled “money wars” – in which nations battle to keep a debilitating US dollar and exaggerated homegrown monetary standards from creasing trades – could be rearranged, with heartbreaking outcomes.

They have dubbed this twilight policy zone “Reverse Currency Wars,” believing that the re-emergence of inflation, a hawkish Fed, and dollar strength will force governments and central banks to reconsider exchange rate orientation and race to keep pace. 

Over the last week,’reverse currency wars’ have become more common. 

The Swiss National Bank’s surprise interest rate hike on Thursday exemplified the policy shift from suppressing the Swiss franc to fend off deflation to embracing its strength as a tool to cool imported inflation. Given that its previous policy resulted in the accumulation of more than $1 trillion in foreign currency reserves, the change could be seismic.

This week, Bank of England policymakers made it clear that they, too, are debating this upside-down world, nervously eyeing sterling’s 14% drop against the dollar in just a year and a 5% trade-weighted pound drop this year alone. 

On Monday, Bank of England rate-setter Catherine Mann stated that one of the reasons she voted for a half-point increase in interest rates last week rather than the quarter-point increase delivered was to avoid additional “inflation imported via a sterling depreciation.” 

An increasingly hawkish European Central Bank is also confronted with record-high eurozone inflation, which has been exacerbated by skyrocketing energy prices and a near-15 percent drop in the euro against the dollar over the past year. 

Japan is in an even worse predicament. It complains almost daily about the yen’s excessive weakness – now at 24-year lows against the dollar – even as the Bank of Japan maintains a policy of capping government borrowing rates through billions of dollars in bond purchases in the face of global inflation and rising yields. 

It’s unclear how long Tokyo can keep doing the latter while worrying about the former. 

Over the past year, emerging economies, many of which face far more destabilising food and energy price inflation, have attempted to anticipate Fed tightening. However, increased dollar strength may force them to tighten the screw even further at a perilous time.

Many people believe that the Fed’s pledge of a “unconditional” war on inflation will put ever-increasing pressure on the dollar in a world where dollar-priced commodity surges entrench inflation expectations everywhere and force all others to ape the US central bank, for better or worse. 

Citi strategist Ebrahim Rahbari believes this all points to global “overtightening,” which would result in lower equities, flatter bond yield curves, and a severe squeeze on financial conditions. 

“Reverse currency wars are strongly bearish for risk assets,” he said, adding that the currencies of dovish central banks and fragile economies are particularly vulnerable.

If such a squeeze hastens a global downturn, the Fed may face significant pressure to ease up. However, war-related energy issues, tight post-pandemic labour markets, and political pressures ahead of the November mid-term congressional elections in the United States argue against any relief this year. 

The upside-down world appears to be here to stay.

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